Piketty and the Vicious Circle of Inequality

Posted on 05 Jun 2014

The academic book of the moment (perhaps the decade) is Thomas Piketty’s Capital in the Twenty First Century. It is hard to think of a public commentator who has not weighed in on the book, from serious examinations of the underlying economic model involved and the difficulties of collecting historical data on investment returns, to less serious thoughts the book’s length or the author’s looks. Capital is primarily about the evolution of economic inequality in developed economies. Piketty has built an enormous dataset tracking inequality over time in France, Britain, the US, and the UK. To a lesser extent the book examines inequality in other countries.

Some commentators on the book have argued that Piketty’s predictions that inequality will continue to grow in this century will not pan out. They argue that rising global growth rates, driven by ongoing industrialisation in emerging markets, may outpace the rate of growth of capital; or that the rate of growth of capital may decrease if technological advances slow; or some other exogenous shock reduces returns on investment; or prudential savings against risks to capital reduce investment returns.

The important insight from Piketty is not that there is an iron law by which inequality grows under capitalism, but a risk that it will grow if constraints are not in place. Important here is not simply the economics of inequality, but the politics.

In the US in particular, there is a risk of entering (perhaps this has already happened) an inequality spiral. Two previous ‘big books’ in development make just this prediction. James Robinson and Daron Acemoglu argue in Why Nations Fail: The Origins of Power, Prosperity, and Poverty that countries with extractive political institutions fail to prosper because entrenched special interests prevent innovative growth from occurring. The authors suggest that the US may be moving from inclusive to extractive institutional arrangements. Similarly, Angus Deaton, in The Great Escape: Health, Wealth, and the Origins of Inequality, suggests that high income inequality risks turning a democracy into a plutocracy, which in turn will undermine the possibility of innovative growth and shared prosperity.

What is the mechanism by which this occurs, and what is its impact on individual lives?

Think of an individual’s well-being as a function of three features of their economic life: the value of the income they receive, the loss (or gain) from taxation and post-tax transfers, and the value of publicly provided goods, both direct (such as health care, security, and education) and indirect (such as a clean environment) from which they benefit.

In a highly unequal country, where pre-tax income rises for those best-off and stagnates or falls for others, if there are not strong constraints blocking the excess political influence of those best-off, one anticipates several inequality-causing political phenomena. First, the very well-off will work to restrict the political influence of the worse off. This may happen through limiting restrictions on campaign finance or increasing restrictions on political participation. Second, one expects this increased political power to be used to reduce taxes (especially but not only for the best off) and a related reduction in post-tax transfers. Third, one expects reduced support for publicly provided goods, like health care and education. Because the financially wealthy and politically powerful can afford to educate their kids and pay their doctors, they see less need to support public health and education.

So perhaps it matters less whether an inherent feature of capitalism is rising economic inequality and more that there is a likely connection between economic inequality and political inequality, which threatens to create greater inequalities not just in income, but in public goods more generally.

Dr Scott Wisor, Lecturer in Philosophy and Deputy Director of the Centre for the Study of Global Ethics, University of Birmingham